Top banks protest CBK freeze of new loan interest rates

The Central Bank of Kenya (CBK) has frozen a bid by banks to raise the cost of loans following the scrapping of lending rate controls on November 7, 2019, drawing protests from the lenders that are suffering reduced profitability.

The regulator had asked banks to submit new loan pricing formulas that would be the basis of setting interest rates on new credit in an environment where the government was not controlling loan costs.

Multiple bank executives told Business Daily that the CBK has not approved their submissions, forcing them to operate as if they are still under lending rate controls to avoid falling in trouble with the regulator.

“Getting approval is a nightmare. CBK has taken a more customer protection approach as opposed to the industry needs,” a bank CEO told Business Daily, seeking anonymity for fear of CBK reprisals.

To play it safe, banks are lending at no more than four percentage points above the Central Bank Rate (CBR) which has been lowered to seven per cent, underlining the conundrum lenders find themselves in.

The bureaucratic gridlock and a lower CBR is partly the reason average lending rates dropped to 11.89 per cent in June – a record low since 1991 when the CBK started making the data public.

The lending rates averaged 12.38 per cent in November last year when rate cap was repealed with CBR then at 8.5 per cent. Banks have been eager to price loans to different clients based on their risk profile but this flexibility remains a mirage after the CBK stepped in as the de facto controller of cost of credit.

The government removed the cap last November after it was blamed for curbing credit growth during its three years of existence. Banks use a base rate that is normally the cost of funds, plus a margin and a risk premium, to determine how much they should charge a particular customer.

The cap, which set rates at four percentage points above the central bank’s benchmark lending for all customers, had taken out that equation and the flexibility that lenders say they need in order to accommodate customers deemed as risky borrowers.

The inability to price risk in lending decisions risks shutting out many prospective borrowers as banks seek to reduce their exposure from already large defaults brought by the Covid-19 pandemic.

The lenders have increased their investment in government debt securities where bids have exceeded Sh100 billion in recent months, underlining increased risk aversion in an economy reeling from the coronavirus fallout.

The CBK which last year warned banks against reverting to punitive interest rates of more than 20 per cent in post-rate cap regime, wants every lender to justify the margins they put in their formulas.

Another bank executive explained that the CBK wants each bank to justify its formula based on factors such as the distribution of loan book to various sectors such as small and medium sized entities.

“We have submitted several presentations to the CBK but it is still seeking more clarity on the model. This has meant that we continue tying the pricing of any new loan to CBR.

“The CBK is treating this model the same way it does with existing products where varying of features such as prices requires the nod of the regulator.”

The Banking (Increase of rate of banking and other charges) regulations of 2006 require banks to seek CBK nod any time they are changing features of any product, such as loans.

“Any change in the features of the product changes the product as earlier approved and, therefore, the changed product with less, more or otherwise varied features must be approved by the CBK prior to roll out,” CBK had reminded banks in a 2016 circular.

Besides the pandemic, the tough regulatory stance taken by the CBK is the other major damper on bank earnings.

The regulator also unilaterally extended the waiver of fees on bank-to-mobile transactions to the end of this year, trimming their non-interest income that would ordinarily pick the slack from lower income from lending.

The waivers, meant to offer financial relief to customers and encourage cashless transactions in the wake of the highly infectious coronavirus, were initially to last for 106 days until June 30.

Banks are now taking an even more cautious approach in extending new loans at a time they are unable to re-price a substantial part of their existing loans that borrowers have sought to repay over longer periods.

Firms and individuals had between March and June restructured Sh844.4 billion or 29 per cent of the loan book as firms’ revenues fell, triggering salary cuts and job losses.

CBK’s tough stand on loans re-pricing started just after the rate caps were repealed on November 7 last year. Assistant director of bank supervision at CBK Matu Mugo issued a memo to bank CEOs on November 26, directing them to retain interest rates on all rate cap regime loans, with room to only vary them downwards.

The memo further directed banks to start submitting monthly reports on interest rates they are charging on loans issued during and after the rate cap regime.

“Please note that failure to comply with this circular will attract appropriate remedial action as provided for under the Banking Act,” wrote Mr Mugo.

CBK data showed that credit to the private sector expanded by 7.61 per cent in the year to June to hit Sh2.69 trillion. This is the slowest pace since January when it grew at 7.3 per cent.

Most lenders have raised their provisioning for loan defaults by as high as three times in appreciation of the persisting economic hardships due to job losses, pay cuts and falling revenues.